Our sister site Tax Insider helps landlords and other taxpayers to understand taxation matters and to reduce their tax burdens. In this second of three guest posts from Tax Insider you can learn how Coronavirus has impacted landlords using the Accrual Basis.
Although much attention has rightly focused on tenants over the coronavirus outbreak period, the crisis may just as likely to be having a large impact on landlords.
Many tenants are struggling to pay their rent because work has stopped or income reduced and as a result many landlords are struggling because they rely on that rental income to fund their own income. Many commercial landlords are receiving thousands of pounds less in rent and service charge payments than they are legally entitled to.
The main provisions relating to private rental in The Coronavirus Act 2020 are that tenants are allowed to ask landlords for a reduction or deferral of rent (initially for three months extended to six to 30 September 2020). A landlord’s ability to forfeit a lease and seek repossession for whatever reason during the period to 30 September has been suspended. The government has shut down the courts and has effectively given tenants an eviction amnesty which could result in some landlords waiting many months to eventually get their properties back. Meanwhile the government has retained the option to extend the 30 September date and the three month notice period.
Many tenants have taken advantage of these measures and have either withheld or reduced their rental payments, the landlord not having much choice but to agree. Even though the Act does not prevent rent or other sums due under a lease from accruing it still means less or no income for landlords. The rent remains the liability of the tenant, not a waiver of the tenant’s liability to pay, so the Act merely gives tenants a breathing space.
Landlords do retain the right to charge interest on the arrears at a rate specified in the lease, to bring debt recovery proceedings against tenants, to draw on rent deposits or other forms of security for payments if deferred payments have not been settled in full by the time the lease expires.
No governments grants have been made available to private landlords however, landlords are able to apply to their mortgage providers to defer mortgage payments for up to six months as are all other mortgagees (see chapter 10 for detail of the measures that are available to landlords). Meanwhile, landlords also have expenses to meet and some may be facing the same challenges as tenants of being furloughed, unemployed or on reduced work. The vast majority of private landlords (85-90%) own one or two properties, many with mortgages, and some may rely heavily on their rental income.
The Accrual Basis
The difference between the two basis is that under the cash basis the income is recognised only when it is actually received into a bank account and relief for expenditure is not given until the payment has been made or incurred, whereas under the accruals basis, a landlord has to recognise income earned and expenditure incurred during a period. Accounts using the accruals basis show the amount of income that was due to be received during the tax year after deducting any expenses relating to the tax year, including any which may have been invoiced but remained unpaid as at 5 April. This means that under the cash basis no adjustments are needed for debtors or creditors, whereas under the ‘accruals’ basis it is necessary to take account of money owed (debtors) and money owing (creditors) and also prepayments and accruals.
This basis of calculation is relevant should rental income exceed the cash basis limits given in section 1.1 above or if the landlord chooses to apply this basis of assessment by ‘opting out’ (see section 1.4 for further detail).
Landlords using the cash basis of assessment are not permitted to claim capital allowances apart from on the purchase of a car. Any other equipment is claimed as a normal allowable business expense (which may produce a more tax efficient claim). Capital allowances on other items can only be claimed if the business qualifies as a FHL or the building is a commercial let. Where allowances are available they are claimable as plant and machinery.
Therefore a landlord of a residential let cannot claim unless the expenditure falls under the Relief for Replacement of domestic items rules where the item being replaced is substantially the same as the old item. This Relief is claimable under both the cash and accrual basis rules but if a capital item is purchased that cannot be claimed under that Relief then the only way of achieving tax deduction is via the use of the ‘accruals’ basis. Whether using the cash basis or not, capital allowances cannot be claimed on expenditure incurred on, or in connection with, the provision, alteration or disposal of an asset for use in an ordinary residential property apart from FHL.
A bad debt is a specific debt that is practically certain not to be paid e.g. where a tenant has disappeared and cannot be traced or they been declared insolvent or bankrupt with there being little hope of recovering the sums owed. No allowances are made for delays in payment unless a provision has been made for unpaid debts previously; this means that if a tenant did not pay the March 2020 payment (although he was supposed to) then the accounts will still include that payment.
Where a landlord has more than one property business, the cash basis test is applied separately to each. Where the cash basis applies by default to more than one business, the landlord can decide whether to remain in the cash basis or whether to apply the accrual basis for each separate business, depending upon which method is more appropriate. Therefore, a landlord can prepare his or her accounts using a different basis for different types of property businesses e.g. accounts for a UK property business could be prepared on a cash basis with an overseas property business opting out to use the accruals basis.
Those with a trade as well as a property business both eligible for the cash basis can decide separately for each (apart from those in a partnership who may not have a choice (see section 1.1 for further detail). Persons other than spouses or civil partners who jointly own a rental property can also individually decide.
Impact Of The Coronavirus
- Bad Debts
Commercial agreements are usually paid quarterly and according to data compiled by Remit Consulting Ltd from six leading property management companies covering close to 80,000 leases, only 48 per cent of tenants paid on time for the March 2020 payment and no doubt a number have been unable to pay the next June quarterly payment.
As section 1.3 states the only way that tax relief can be obtained for non-payment of rent under the accrual basis is by making a claim that the payment is a ‘bad debt’. The problem under coronavirus is that a landlord may not know whether the non-payment will eventually be a bad debt and as such will be liable to pay tax on the non-payment amount (although one of the government’s initiatives for all self-assessment taxpayers was the deferment of the 31 July 2020/21 second payment on account for payment by 31 January 2021).
- ‘Opting out
‘Opting out’ of the cash basis is via election on the personal tax return but note that this is for one tax year only. Unless a further election is made on the subsequent tax return then the cash basis automatically applies so long as the eligibly conditions are met. Therefore if a landlord opted out of the cash basis applying for accrual basis for the tax year 2019/20 and then found that for the tax year 2020/21 rental payments were not being made as a result of the coronavirus (i.e. calculating that the cash basis would be more beneficial) then there is no need to notify HMRC as the cash basis will automatically apply. Should the calculations show that rather than the cash basis the accrual basis would be more beneficial for 2019/20 but the tax return for that year had already been submitted and did not show a claim to opt out, then an amended return can be submitted by the deadline of 31 January 2021.
Written by Jennifer Adams:
Jennifer Adams is a property tax specialist with a flair for helping clients structure their financial affairs in a tax-efficient manner. She appreciates the tax problems of property owners having a property portfolio herself. Jennifer writes for many leading publishers and can be relied upon for simple, straightforward advice. She runs her own accounting practice and her advice and specialist knowledge enables all of her clients to pay the least amount of tax that is legally possible.
Tax Insider publishes monthly newsletters and reports for everyone with an interest in responsible tax saving, including professional advisors, landlords, property investors, business owners, and general UK taxpayers. For more information and the latest property tax saving tips, visit the Tax Insider website.
Look out for part 3 where Jennifer looks at whether the accrual or cash basis is best to use in an age of coronavirus and what landlords should be aware of when electing which basis to use.
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